Cost-Volume-Profit Analysis

Managers, in making their decisions affecting the business operations must understand the
interrelationship of cost, volume and profit through the use of the information and analysis that the
cost accounting department will provide to them. They need to understand which costs would vary
with changes in volume and which costs would stay the same. The important information that are
needed in studying the CVP relationship are:

1. Unit Selling Price

2. Unit Variable Costs
3. Total Fixed Costs
4. Relevant Range

If the above items are known, the following relationships may be established:

a) Contribution Margin per unit

a. This is the excess of unit selling price over unit variable costs and the amount each
unit sold contributes toward
1. Covering fixed cost and
2. Providing operating profits.
b) Break-even point
b. This is the level of sales volume where total revenues and total expenses are equal,
that is, there is either profit or loss. This can be computed as follows:

1) Break-even point = ______Total Fixed Cost_____

(Units) Contribution Margin per unit

2) Break-even point = ______Total Fixed Cost_____

(Peso) 1- Variable Costs_____
Sales

3) a. Break-even sales for = ____Total Fixed Cost___

Multi-products firm Weighted Contribution
(combined units) Margin per unit

b. Weighted Contribution (No. of units no. of units

Margin per unit = _Unit CM x per Mix)_ + _(Unit CM x per Mix)_
Total number of units per Sales Mix

4. a. Break-even sales for

 Multi-products firm (P) = __Total Fixed Costs_
Weighted CM ratio

b. Weighted CM ratio = __Total Weighted CM (P)__

Total Weighted Sales (P)

c) Target Sales Volume

c. This amount of sales needed to earn a desired amount of profit. The equation that may be
used to compute for this is:

Sales (units) = __Total Fixed Costs + Desired Profit__

Contribution Margin Per Unit

Sales (peso) = ____Total Fixed Costs + Desired Profit_____

Contribution Margin Ratio (% of net sales)

d) Margin of Safety (MS)

d. This is the excess of actual or budgeted sales over break-even sales indicate the amount by
which sales could decrease before
losses are incurred. Once the margin of safety is determined, the
MS ratio may be computed as follows:

MS Ratio = ___Margin of Safety (P)___

Actual or Budgeted Sales

e) Break-even Graph
e. Under the graphical approach, sales revenue, variable cost and fixed costs are
plotted on the vertical axis while volume is plotted on the horizontal axis. The
break-even point is the point where the total sales revenue line intersects the total
cost line.

Illustrative Problem 1-2. Construction of Break-even Graph

Prepare the break-even graph for MNO Corporation based on the following information:

Total Per Unit

Net Sales P 500,000 P 10

Variable Costs _300,000 __6
Contribution margin P 200,000 P 4
Fixed Costs _ 150,000 __3
Net Profit _P 50,000 _P 1

Number of units sold – 50,000

f) Profit-Volume Chart
 f. This chart focuses more directly on how profits vary with changes in volume.
Profits are plotted on the vertical axis while units of output are shown on the
horizontal axis. Using the data of in illustrative Problem 1-2.

Assumptions and Limitations of CVP Analysis

CVP analysis constitutes a very important tool for management planning. Certain
underlying assumptions upon, which it rests, however, place definite limitations on the conclusions
which can be drawn from it results.

Whenever underlying assumptions of CVP analysis do not correspond to a given situation, the
limitation of the analysis must be clearly recognized if the break-even tool is to be useful and
educational.

In summary, the following static assumptions will limit the precision and reliability of a
given break-even analysis.
Assumptions Comment

1. The analysis is valid for a limited 1. Failure to observe these limits

range of values – the “relevant” would lead to working with
– and a limited period of time. unrealistic data.

2. All costs can be categorized as fixed or

variable. 2. Sem-variable costs presents a
a. Variable costs change problem that can be solved by
proportionately with segregating fixed and variable
volume within the relevant portion.
volume range. a. There is a danger that
b. Fixed costs are constant linear cost and revenue
within the relevant volume relationship may be used
range. when non-linearities are
significant.
b. Non-linear curves often
have optimum quantities;
linear ones do not.

3. Price is constant for all volumes

3. Revenues change proportionately with
volumes with selling price remaining
constant.
4.
4. There is a constant product mix.
within the relevant range.
Data should be adjusted for any shifts
in product mix.

5. There are factors affecting costs and

5. Changes in volume alone is responsible revenues, but they
for changes in costs
 and revenues.
6. There is no significant change in
inventories (i.e., in physical units, sales
volume equals production volume.)
7. Operation leverage questions can be
dealt with the CVP framework.
8. The analysis is deterministic and
appropriate data can be found.
are lessened if narrow time
and volume limits are applied.
6. Data should be adjusted if in
inventories change markedly.
7. This should be supported with capital
budgeting approaches that consider
the time value money.
8. Uncertainty and a probabilities
approach can be introduced. This will
change decisions in some cases.